Biggest shake-up coming for insurance accounting
IMELDA D. MANGUNDAYA
International Financial Reporting Standard (IFRS) 17, Insurance Contracts, is considered the biggest shake-up in insurance reporting for decades, affecting all insurers reporting under IFRS.
The International Accounting Standards Board (IASB) released the final standard internationally in May 2017. The Financial Reporting Standards Council (FRSC) locally adopted it in March 2018. It will be effective January 1, 2021 with prior year comparative reporting required.
Building blocks of change
IFRS 17 requires measuring insurance contract liabilities based on these building blocks:
• discounted, probability-weighted estimates of cash flows –comprising of inflows (e.g. premiums) set off by outflows (e.g. claims, benefits, options, guarantees, acquisition costs, claims handling expenses);
• risk adjustment to address the uncertainty of cash flow estimates; and
• contractual service margin or CSM, the unearned profit of the contract.
Cash flow estimates are measured at each reporting period using the current measurement model. It provides for three measurement approaches: the Building Block Approach or BBA (for long duration contracts, more than 12 months), the Premium Allocation Approach or PAA (for short duration contracts, 12 months or less),and the Variable Fee Approach or VFA (for contracts with direct participation feature, e.g.unit-linked products).
Moreover, IFRS 17 calls for a number of options and judgments that insurers have to strategically think about.
Transforming the industry
Insurers will no longer be able to front-end at the time of contract issue projected profits. Under IFRS 17, these profits will be held back in a new insurance contract liability component called the contractual service margin (CSM) and will be recognized into income over the coverage period of each group of contracts. Short and single-pay products will now have lower internal rate of return. This calls for a revisit of product design.
Losses at contract inception are now immediately recognized in the profit and loss statement and can’t be offset with profitable products. This will require speed in repricing when profitable products become onerous (i.e. results in loss) due to unfavorable experience and interest rate movements.
The insurers’ CSM on in-force business at transition compared with CSM on new business will be critical drivers of overall profitability. A larger CSM from in-force business at transition may be appealing. But without new business with comparable CSM, profitability will reflect a downward trend.
Reinsurance will no longer relieve earnings and capital strain from high first-year costs and capital requirements on new business. This is because CSM for reinsurance is set to eliminate reinsurance profit or loss at contract inception. Smaller insurers relying on reinsurance to sell larger insurance contracts will now be pressured to compete in that market. Likewise, it may affect the pricing of large insurance portfolios sold by larger insurers.
The interest credited to insurance cash flows of insurance liabilities will no longer be tied to return on assets supporting those liabilities. This will put a strain on insurance liabilities and drive earnings volatility from market movements.
The face of financial statements, notes disclosures, insurance liability measurement, and profit signatures is changing significantly. This will in turn require changes to data feeds, actuarial systems, general ledgers and sub-ledgers, reporting systems and data, and business processes and controls.
Income tax implications are another key aspect. Generally, IFRS 17 requires transition adjustment and deferral of earnings which can result in previously recognized (and taxed) income recycling back into current year results.Tax authorities may need to issue clarified tax rules on taxability of IFRS 17 transition adjustment and deferral of income scenario.
The Insurance Commission (IC) may have to revisit its rules under insurance industry ranking and the Amended Risk-Based Capital (RBC2) Framework. For industry ranking, the income statement will no longer reflect gross premiums written but will be replaced by insurance service results, representing earned income. For capital requirement, the one-time equity effect of transition adjustment may trigger capital build-up plan or capital call from shareholders to comply with RBC2. Clarified guidance by the IC may be essential in this changing insurance landscape.
Business performance metrics (product pricing and design, investment decision, asset-liability and capital management, among others) may need to be updated to align with these changes.
Bracing for impact
An in-depth understanding of the standard, gap analysis, and impact assessment exercise will be fundamental to deliver an effective IFRS 17 implementation strategy. Key stakeholders’ involvement will be imperative, specifically around key judgment and decision points. Decisions to pursue compliance versus strategic path should be carefully considered to support a sustainable business model. Before the effective date, insurers will need to think about their ‘IFRS 17 story’ for stakeholders, investors and market analysts as well as the key metrics they will apply in the new scenario.
Sure, the greatest shake-up is out there. But an effective IFRS 17 readiness and implementation blueprint will give insurers a safe harbor as they navigate through these great changes and unchartered waters.
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Imelda D. Mangundaya is a partner from Assurance, and Assurance Risk Management of Isla Lipana & Co., a member firm of the PwC network. For more information, please email markets@ph.pwc.com. This content is for general information purposes only and should not be used as a substitute for consultation with professional advisors.
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